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Leading paints companies such as Asian Paints, Berger Paints (Berger) and Kansai Nerolac (Kansai) put up a subdued performance for the December 2014 quarter. Unlike the recent past, volumes grew in single digits impacting the core revenues of Asian Paints, Berger and Kansai.
However, margins were aided by benign input costs leading to a 40 basis points to 164 basis points year-on-year earnings before interest, tax, depreciation and amortisation (Ebitda) margin expansion for these companies. Margin gains along with non-operating factors such as lower tax rate and higher other income aided net profit growth for two of these companies.
The question now is whether this slow growth is a one-quarter aberration (due to pre-ponement of festive season) or has the overall slowdown finally caught pace with paints companies as well?
Key takeaways from a concall held by the management of India’s largest paints company, Asian Paints, suggest that there is a slowdown in demand across regions. The other companies also witnessed subdued demand in both urban and rural markets. Berger’s concall is scheduled for February 4. What’s more, Asian Paints’ management believes a recovery will be gradual.
Additionally, the rich stock valuations of the three companies more than adequately factor in the gains from softening crude oil price and are a mismatch with weak demand trends.
Analysts at Prabhudas Lilladher believe that the recent rally in Asian Paints’ share price led by expectations of unrealistic margin expansion and profit growth has taken the stock to all-time high valuations, which might not be sustainable. He has downgraded the stock to ‘Reduce’ post weak numbers and reduced FY17 earnings estimates by four per cent. His target price for the stock currently trading at Rs 808 is Rs 745.
At current market price, the Asian Paints scrip trades at 39 times FY16 estimated earnings per share, while Berger and Kansai trade at 23 times and 36 times, respectively. This is much above their historical average one-year forward price/earnings ratio of 30 times, 20 times and 25 times, respectively. All the three stocks made all-time high in the month of January 2015.
Nevertheless, average target price of analysts polled by Bloomberg in 2015 so far stands at Rs 852 for Asian Paints (upside of five per cent from current price) and Rs 217 for Berger (downside of two per cent). For Kansai though, the target price is Rs 2,654 indicating potential upside of 13 per cent.
But, there’s a big tailwind going in favour of paint companies, which is the fall in crude oil prices from over $100 a barrel to $50 levels currently. Gross margin of paints companies is expected to improve further due to benign crude oil prices. Notably, titanium dioxide and other crude derivatives such as Phthalic Anhydride (PAN) and Pentaerythritol (Penta) together form about 40-50 per cent of total input costs for these companies. As per analysts’ estimates, every 10 per cent fall in these inputs prices adds 7-10 per cent to paint companies’ earnings. However, companies are likely to pass on part of these gains in their bid to keep competition under check or expand market share, say analysts. But, how much of the expected price cuts will lead to higher volumes is yet to be seen.
Also, it was due to the falling input costs and hopes of a revival in demand led by economic revival that paint companies have seen a re-rating in recent months; their stocks are up between 35-55 per cent since August 2014 suggesting that the gains are largely priced in for now.
There is little doubt over the companies’ long-term growth potential as analysts believe shift towards premium products, higher frequency of repainting cycle and better purchasing power of the end user will drive growth in the paints sector. Strong distribution network and improving brand equity of the leading players should also help capture higher share of the expanding market. Kansai, which has highest exposure to industrial paints segments (50 per cent of revenues, versus 20-22 per cent for the other two companies), also stands to gain most from pickup in this segment. However, some analysts have started to question the near-term growth visibility given the recent performance and management commentary. The jury is still out.
